Lessons from a Private Equity Earn Out: How I Lost £550K Due to a Lowercase 'C'

I used to be a lawyer in SV, and whenever my lawyer friends talk about earnouts, it's always in the context of what a bad deal they are for founders.

Basically, they take a lot of lawyer time to negotiate, in order to make them as close to airtight as possible. And if anything goes wrong, it takes a lot of lawyer time to resolve them. And lawyer time equals money (as much as $2k/hr, billed in 6 minute-increments). So you could pay six figures negotiating an earnout, and another six figures when things don't go as planned. That doesn't mean they're always a bad idea — just the vast majority of the time.

A candid lawyer will counsel you away from an earnout, and if a lawyer doesn't mention the potential downsides of earnouts, I'd consider that a big red flag.

When dealing with private equity, there are three things to remember:

1.) You may negotiate with them two or three times in your life. They negotiate with people two or three times a day. You are the least experienced and most vulnerable party.

2.) They are not your friends. They’ll pretend but they’re not. If you’re in music, think better paid A&R with fewer morals.

3.) If a term can sink a deal, they were never interested in signing. Adults can deal with disagreements without crashing the whole plane.

If you read this carefully you'll notice this story is presented back to front.

>revenue must not have involvement with "connected parties."

>disclosed that two of my shareholders also worked at companies that were customers

...and surprise surprise the revenue gets disputed. Disclosing things doesn't invalidate pieces of the contract - if anything it strengthens it given solid evidence to the opposing party here.

That's it. End of story. And yes, good advice - lawyers may have saved this.

The rest reads like the result of a desperate laymans search for anything that might back an alternate interpretation....absolutely anything that might get these two obviously excluded revenue pieces back into scope. To call it a longshot would be generous:

>Had the "C" in "connected parties" been capitalized, it would have fallen under the HMRC Taxation of Chargeable Gains Act, which in the UK formally defines a Connected Party as a person who has control of a company, which was not the case with either of my shareholders.

Why would UK tax law definitions have any bearing on interpretation of what revenue is in scope for a valuation calculation?

But lets assume it somehow is via some unnamed mechanism. The act doesn't even mention "Connected Party" let alone define it. It does talk about connected persons but you'd need to squint pretty hard to turn party in persons via a capital C...and ignore the minor detail about it dealing with tax matters not M&A matters.

I'm gonna go out on a limb here and say there was no lawyer involved in the capital C part of the story at all.

Great article and great takeaways. People should always keep in mind that in business people are not your friends. Does not mean they are evil though. The takeaway here is the what I take as the main point. Hire proper legal representation.

I feel the biggest issue was that there was a desperation for the sale which caused to the OP to agree to something out of their comfort zone and experience.

Once you do that, the advantage is for the acquiring company.

Excellent advice.

I’m not convinced that it’s possible to get the 100-day integration to start only after the earn-out is completed.

Anybody managed to get this in the sale agreement?

I feel like in general, the complex structures and legalese in the startup world are set up against founders and against employees. Is there anyone pushing for simplification or standard forms or structures that are not just in the VC’s or acquirer’s interests?

The "P" in "Parties" also needed to be capitalized.